Today, in the second of our 4 week series on investing, we’re talking about the common types of retirement investment accounts offered by employers, self-employed or small businesses. We'll discuss the different types of accounts, their benefits and drawbacks, and who they're best suited for.
Types of Investment Accounts
There are many different types of investment accounts available, but some of the most common include:
● Individual retirement accounts (IRAs): IRAs are tax-advantage accounts that can be used to save for retirement. There are two main types of IRAs: traditional IRAs and Roth IRAs. Traditional IRAs allow you to deduct your contributions from your taxable income, while Roth IRAs do not. However, withdrawals from Roth IRAs are tax-free, while withdrawals from traditional IRAs are taxed as income.
a. 2023 IRA Contribution Limits are $6,500 or $7,500 over age 50 with catch up contribution provisions. However, keep in mind eligibility is based on income levels.
b. 2023 Modified Adjusted Gross income under $138,000 as single and phasing out at $153,000. For Married Filing Jointly the MAGI must be under $218,000 combined for full contribution phasing out up to $228,000.
● 401(k) plans: Named after the Internal Revenue Services subsection 401(k) originally as a supplement to pension plans are now primarily used as the main for profit employer-sponsored retirement plans. It is a tax-deferred, defined contribution plan that allow employees to save money from their paychecks before taxes are taken out. 401(k) plans offer a variety of investment options, and contributions are typically matched by employers.
a. The Roth 401k option was later introduced in 2006 and many plans give employees the option of pre-tax 401k or post-tax Roth 401k contributions. However, any matching or profit-sharing from the employer will go into the 401k bucket for employer tax deductions.
b. 2023 Max Employee Contributions amounts are $22,500 or $30,000 if you are aged 50 and older and are annually updated due to inflation.
c. NOTE: If you are fully contributing to your 401k, any IRA contributions would be non-deductible and may not be as effective. However, if your spouse doesn’t work or have an employer sponsored plan – you may consider a spousal IRA contribution annually.
● 403(b) plans: 403(b) tax-advantaged retirement plans are similar to 401(k) plans, but they are offered by non-profit organizations and government employers.
● Health savings accounts (HSAs): HSAs are tax-advantaged accounts that can be used to pay for qualified medical expenses. HSAs offer a triple tax advantage:
contributions are tax-deductible, earnings are tax-free, and withdrawals are tax-free.
● 529 plans: 529 plans are tax-advantaged savings plans that can be used to pay for qualified education expenses. Contributions to 529 plans are not tax-deductible, but earnings grow tax-free and withdrawals are tax-free.
Lesser known retirement accounts
SEP IRA: A simplified employee pension (SEP) IRA is a retirement plan that allows self-employed individuals and small business owners to make tax-deductible contributions to a retirement account. SEP IRAs offer many of the same benefits as traditional IRAs, but they have some key differences. For example, there is no income limit for making contributions to a SEP IRA, but contributions are limited to the lesser of 25% of business revenue or 20% in a sole proprietorship with a maximum amount adjusted for inflation of $66,000 in 2023. No Roth Option Available.
Solo 401k: With some similarities to 401k’s the Solo 401k is for self-employed individuals with no employees or a couple running a business jointly. It does have both traditional 401k or Roth options available with an easy, straightforward paperwork. Contribution maximums are the same as any employee, but you can also contribute up to 25% of compensation with a total limit of $66,000 in 2023.
SIMPLE IRA: A savings incentive match plan for employees (SIMPLE IRA) is a retirement plan that allows small businesses to offer retirement savings plans to their employees. SIMPLE IRAs are similar to 401(k) plans, but they have some key differences. For example, there is no vesting schedule for contributions made to a SIMPLE IRA, and employers may elect one of 2 matching contributions.
Option 1: dollar for dollar match up to 3% of employees compensation.
Option 2: a 2% flat contribution to all employees with a max compensation of $330,000.
Employer Contribution Limits: are much lower with a max of $15,500 for 2023, or a catch-up max of $19,000 for employees age 50 and older.
2024 Changes: Due to SECURE Act 2.0 the SIMPLE IRA Plans also will allow additional contributions to employee accounts with a contribution of the lesser of 10% of compensation or $5,000 (indexed for inflation). Also, a Roth option will be introduced in 2024.
457(b) plan: A 457(b) plan is a supplemental retirement plan that is offered by state and local governments and tax-exempt organizations. 457(b) plans offer many of the same benefits as 401(k) plans, but they have some key differences. For example, they are not qualified retirement plans, so withdrawals before 59 & ½ aren’t subject to early withdrawal penalties.
IRA Conversion to Roth: An IRA conversion Roth is a process of converting an existing traditional IRA or 401(k) plan to a Roth IRA. When you convert an IRA, you will have to pay taxes on the amount of money that you convert. However, once the money is in the Roth IRA, it will grow tax-free.
Multiple Retirement Accounts: You can have a solo 401(k) even if you're moonlighting. If you have a 401(k) plan at both jobs, the total employee contribution limits must be within the maximum for the year, but the employer contribution is not limited. If you're one of these lucky folks with two retirement savings plans, talk to a tax or financial adviser to make sure you follow the IRS rules.
These are just a few of the less known retirement accounts that are available. It is important to do your research and compare different accounts before you make a decision about which one is right for you.
Benefits and Drawbacks of Different Investment Accounts
The benefits and drawbacks of different investment accounts vary depending on the account type. Some of the factors to consider include:
● Tax benefits: Some investment accounts offer tax advantages, such as tax-deductible contributions or tax-free withdrawals.
● Investment options: Different investment accounts offer different investment options. Some accounts may offer a wider variety of investment options than others.
● Contribution limits: The contribution limits for different investment accounts vary. Some accounts may have higher contribution limits than others.
● Early withdrawal penalties: Some investment accounts may have early withdrawal penalties. These penalties are typically imposed if you withdraw money from the account before you reach a certain age.
Who Are Different Investment Accounts Best Suited For?
The best investment account for you will depend on your individual circumstances. Some factors to consider include your age, your income, your risk tolerance, and your investment goals.
If you are a beginning investor, you may want to consider a low-cost index fund that tracks a broad market index, such as the S&P 500. Index funds are a good way to diversify your portfolio and reduce your risk.
If you are saving for retirement, you may want to consider a 401(k) plan or an IRA. These accounts offer tax advantages that can help you grow your retirement savings.
If you have high-deductible health insurance, you may want to consider an HSA. HSAs can help you save money on medical expenses and can be used as a retirement savings vehicle.
If you are saving for a child's education, you may want to consider a 529 plan. 529 plans offer tax advantages that can help you save for college tuition.
Conclusion
There are many different types of investment accounts available, and the best account for you will depend on your individual circumstances. It is important to do your research and compare different accounts before you make a decision.
Comments